Solution for Quiz1 Chp1 Ac409 Essay
AC409 Student Name:________________ Lecturer: Innge Handojo, BSBA. , MAcc. Problem One: Balance Sheet Reconstruction You want to prepare the balance sheet for Usher Inc. as of December 31, 2005. Use the following information. All information pertains to fiscal 2005 unless otherwise stated. [pic] Solution Problem one: Balance Sheet Reconstruction [pic] [pic] Problem Two: Equity Valuation In the table below is selected information for Sprigue Company. All figures are in thousands and represent expectations of the future. [pic] a.
Calculate the expected free cash flow to equity for the years 2005 to 2009.
b. Explain the expected changes in debt levels over the five years Solution Problem Two: Equity Valuation a. [pic] b. This company is clearly in a growth phase from 2005-2009 as evidenced by the growth in net income and the net new investment in capital assets and working capital. During high growth phases a company will often find that it needs additional financing to fund the growth. This company is expecting to fund this growth with equity in 2005 and debt in 2006-2009.
After 2006 when the growth slows down the company starts to generate positive cash flows from operations and has no need of additional external financing. Problem Three: Equity Valuation A friend tells you that you should buy Leclerc Company stock as it is a “great deal”. It is January 1, 2006 and the stock is trading at $25 per share. You obtain the financial statements for Leclerc and determine the following: 1. Book value is $12 per share as of December 31, 2005 2. Earnings for 2005 were $4. 0 per share 3. Earnings are expected to grow at 20% for the next four years 4.
Dividend payout is 40% 5. Residual income is expected to be zero from 2007 onwards 6. Cost of equity capital is 15% Determine, using the residual income method, whether you should buy Leclerc stock as of January 1, 2006. Solution Problem Three: Equity Valuation You should not buy Leclerc stock as the intrinsic value is below the current market price. [pic] Problem Four: Valuation of Bonds a. It is January 1, 2006 and you are considering buying $20,000 of Hilever Company’s 10% bonds, which come due on December 31, 2015.
The bonds pay interest semi-annually on June 30 and December 31 of each year. The prevailing interest rate on bonds of similar risk is 12%. How much would you be prepared to pay for the bond? b. If coupon rate was 12% on these bonds, how much would you be prepared to pay? c. If the coupon rate was 10% and the bonds were convertible into common equity (5 shares for every $1,000 face value coupon bond), and common stock is currently trading at $11 per share would this change your answer to part a? Why? Why not? Solution Problem Four : Valuation of Bonds . Semi-annual interest equals $1,000 ($20,000 x . 10 x 0. 5) Semi-annual interest will be received for 20 periods Discount rate = 6% (semi-annual) Principal of $20,000, discounted for 20 periods at 6% Value of bond = $17,706 b. $20,000 (coupon rate equals required return so bond will sell at par) c. Yes. Even though you would not want to convert currently at $11 per share, the conversion feature is equivalent to owning an out-of-the-money stock option and has some positive value. Therefore, you would be prepared to pay more than in part a.